Economics

Regulation

The bad horribles

Aug 1st 2012, 13:52by R.A. | WASHINGTON

FOR over a year, the Treasury Department has been trying to gin up more assistance for struggling underwater homeowners. It has been pressing the Federal Housing Finance Agency, run by Edward DeMarco, to offer principal reductions on mortgages held by Fannie Mae and Freddie Mac, which are under the FHFA's control. Treasury threw a lot at the effort, which probably would have left Fannie and Freddie in better financial shape. Mr DeMarco nonetheless refused to agree to the programme.

This has prompted an understandable wave of outrage. Much of the justifiable anger stems from Mr DeMarco's argument that while the plan might be good for his agency, it could cost taxpayers money. That is surely Treasury's problem to worry about, not Mr DeMarco's. Frustration also stems from the apparent missed opportunity; FHFA's own analysis suggests that as many as half a million homeowners could benefit from the programme, which might actually save $1 billion in taxpayer money if the borrowers that receive assistance become more likely to stay current on their loans.

But while Mr DeMarco's behaviour in this case looks rash and imperious, not all of his concerns are entirely misguided. He writes:

Perhaps the greatest risk of the Enterprises’ allowing principal forgiveness is one with far more significant long-term consequences for mortgage credit availability. Fundamentally, principal forgiveness rewrites a contract in a way that other loan modification programs do not. Forgiving debt owed pursuant to a lawful, valid contract risks creating a longer-term view by investors that the mortgage contract is less secure than ever before. Longer-term, this view could lead to higher mortgage rates, a constriction in mortgage credit lending or both, outcomes that would be inconsistent with FHFA’s mandate to promote stability and liquidity in mortgage markets and access to mortgage credit.

[T]the weirdest thing about this argument is that the horribles aren’t particularly horrible. Higher mortgage rates? Um, fine: no one is exactly complaining that mortgage rates are too high right now. A constriction in mortgage credit lending? That’s fine too: it was too-lax credit lending that caused this whole problem in the first place. Both together? Even that’s fine: it would help bring homeownership rates down from their current too-high levels, and encourage more people to rent rather than own, creating a more flexible national labor force.

The key question here is whether these will only be long-term problems or whether they may materialise quickly. Over the long term, it's no bad thing to make homeownership in America a little more difficult and expensive. In the short term it might well be. At the moment, low mortgage rates are helping keep many struggling borrowers afloat and bringing buyers back to a market that remains depressed and illiquid relative to normal times. Mortgage lending standards were far too loose during the boom but have since tightened considerably, arguably too much so.

A housing-market recovery in America is long overdue. Given striking weakness across the global economy, a housing rebound couldn't come at a better time. Broad principal reductions might well be just the thing to get its momentum going, but it's not silly to worry about unpleasant side effects.